After success on Iran, U.S. Treasury's sanctions team faces new challenges

WASHINGTON (Reuters) - This is what the modern American war room looks like: the clocks on the wall show the times in Kabul, Tehran and Bogota. The faces around the conference table are mostly young. There is talk of targets, and of middle-of-the-night calls to Europe.

But the meeting one recent morning convened deep within the Treasury Department, not the Pentagon. The weapons at hand were not drones or cruise missiles, but financial sanctions, aimed with similar precision at U.S. rivals' economic interests.

Before discussing possible next steps against Russia over its annexation of Crimea, Adam Szubin, the slim, boyish-looking director of Treasury's Office of Foreign Assets Control (OFAC), thanked his team for putting in a string of sleepless nights to devise sanctions against senior Russian officials and associates of President Vladimir Putin.

The measures, rolled out in three executive orders signed by President Barack Obama in March, included blocking the Russians and Bank Rossiya, Russia's 17th-largest bank, from access to the U.S. financial system and freezing their U.S. assets.

The sanctions were partly symbolic, more intended to send a message to Russian leaders than damage Russia's economy. It wasn't clear whether they would be enough to pressure Putin to stop Russia from forcibly asserting territorial claims elsewhere, let alone reverse the annexation of Crimea.

But during Reuters' up-close look at how OFAC devises sanctions, one thing did seem certain to Szubin's team.

"We're going to be looked to ... in the days and weeks to come, to continue to deliver," Szubin, 41, told about 30 staff members gathered over a modest celebration of Starbucks coffee and Krispy Kreme doughnuts.

His prediction was borne out on Sunday, when Samantha Power, the U.S. envoy to the United Nations, said the United States was prepared to step up sanctions against Moscow if pro-Russian military actions in eastern Ukraine continued.

By turning to sanctions in response to Russia's intervention in Ukraine, Obama reinforced a trend: He - and George W. Bush before him - increasingly have used financial warfare, rather than the overtaxed U.S. military, in crises from North Korea to Iran to Syria.

It has made OFAC's war room something of a front line for the United States and its allies. In interviews, current and former top OFAC officials offered insight into some of the often-secret agency's inner workings, including its key role in imposing economic penalties on Iran.

The 170-person sanctions unit within Treasury, comprised mainly of lawyers and intelligence analysts known as "targeters," has extraordinary powers - and the ability to interrupt dollar transactions worldwide.

Lawyers and companies who must deal with OFAC to comply with its sanctions complain that it often imposes penalties without sharing key evidence to support its actions. Some also say OFAC can overreach in blocking transactions it deems suspicious.

Among those hit with Ukraine-related sanctions was Russian businessman Gennady Timchenko, co-founder of leading global commodities trading firm Gunvor. The firm disputed Treasury's March 20 claim that Putin had investments in the firm "and may have access to Gunvor funds."

Putin has mocked the U.S. sanctions, which his spokesman, Dmitry Peskov, has called "unacceptable." U.S. Treasury officials have declined to produce any proof Putin is involved with Gunvor, and are not required to under U.S. law.

"OFAC is probably one of the most powerful government agencies no one's ever heard of," said Mark Dubowitz of the Foundation for Defence of Democracies think tank, which backs tough sanctions on Iran over its suspected nuclear weapons work.

But Treasury, along with the U.S. Congress and the European Union, quieted many sceptics who said sanctions on Iran would fail. Tough oil and financial restrictions apparently pushed Tehran into negotiations over its nuclear program, which the U.S. and its allies see as a potential threat to Israel in particular.

Thanks partly to the Iran success, the United States faces two major challenges in waging financial warfare, current and former officials say.

It took Washington years to win international consensus on targeting Iran's energy exports, and sanctions were imposed in stages. If negotiations with Iran succeed, it will be even more complex to reward Iran by gradually unwinding the thick web of restrictions on doing business there, officials acknowledge.

Some former officials also predict that the United States, after leveraging its dominance in the global financial system to punish adversaries, could itself become the target of financial attack by countries such as China and Russia.

DRIED FRUIT AND ZIRCONIUM SAND

OFAC's targets are broadly set by White House orders to use financial tools against a specific country, or adversaries such as violent Islamic militants. But individual cases often stem from lengthy investigations by its Office of Global Targeting.

And sometimes, tips come in unsolicited.

In the middle of international nuclear talks with Iran last fall, a financial institution phoned OFAC about a suspicious transaction. A Japanese company that billed itself as a seller of fresh and dried fruit was sending money to a Hong Kong firm, said a senior U.S. official who was not authorized to speak publicly about the case.

The transaction wasn't huge - tens of thousands of dollars - but it raised eyebrows at OFAC.

The Japanese firm, Tistria Inc., had an Iranian affiliate, the U.S. official said. And the Hong Kong company made zirconium sand, a key ingredient in zirconium tubes, used in heavy-water nuclear reactors. The U.S. official did not identify Tistria's Iranian affiliate.

"Zircon sand has a whole range of industrial uses. But ... none of them are in the display or sale of fruit, dried or otherwise," the U.S. official said. OFAC blocked the U.S. dollar transaction, which has not been reported previously.

Tistria declined to comment. When Reuters called the Iranian affiliate listed on Tistria's web site, Yar Trading Group, the company's chief executive said he has not had ties with Tistria since 2009, did not know about the blocked transaction and did not know why his firm was still listed on Tistria's web site.

A Treasury spokeswoman declined to comment on the Tistria case.

Word of the blocked transaction was passed to U.S. delegates

at the nuclear talks in Geneva, who confronted the Iranians across the table with the information. The tacit message: The United States is watching you, and will continue to vigorously enforce existing nuclear sanctions.

Most investigations require more labour, as OFAC's targeters comb through classified intelligence reports, financial records and corporate registrations. They build charts illustrating how striking one financial node will impact other nodes, those familiar with the process said.

After OFAC shifted its focus in late 2012 from imposing new Iran sanctions to hunting for those who may be violating such sanctions, one name kept popping up: Babak Zanjani, an ambitious Iranian businessman whose network of 65 companies stretched from Turkey to Malaysia. The U.S. government would accuse him of violating sanctions by selling billions of dollars worth of Iranian oil in covert transactions.

To OFAC targeters, Zanjani's business structure threw up red flags: a Turkish cosmetic company that owned a Tajik financial institution that in turn owned an Islamic bank in Malaysia.

"Zanjani was brash, but in the end not necessarily so bright," Szubin said.

Zanjani's empire was dismantled in a one-two punch. He and his businesses were hit by E.U. and U.S. sanctions. Then he got entangled in Iran's power shift when President Hassan Rouhani replaced Mahmoud Ahmadinejad. The new Iranian government accused Zanjani of owing the nation more than $2.7 billion in oil proceeds.

Arrested in late December, Zanjani has denied wrongdoing. It

is unclear what charges, if any, he faces in Iran.

'WE LEARNED ... HOW HARD IT IS'

In late 2012, Iran's economy began to wobble. It was losing billions of dollars per month as sanctions slashed its oil sales. Its currency plunged, inflation jumped and the economy went into recession.

In an interim nuclear deal with Iran reached in November, U.S. and E.U. negotiators agreed to lift sanctions on sectors such as petrochemicals and precious metals for six months. They have promised broader sanctions relief if Iran agrees to permanent curbs on its nuclear program.

However, the last time the U.S. government eased sanctions to spur nuclear diplomacy, it did not go well.

In 2005, Treasury used a powerful anti-money laundering tool, Section 311 of the Patriot Act anti-terrorism law, to blacklist Macau-based Banco Delta Asia, which it said was used by North Korea for illegal activities. The move sent a signal to the global banking system that North Korea was off-limits.

When $25 million in accounts was unfrozen to coax Pyongyang back to nuclear talks, U.S. diplomats struggled to find a financial institution willing to handle the funds. They were forced to use the New York Federal Reserve Bank. That choice and the decision to lift sanctions for political reasons allowed North Korea to regain some financial legitimacy.

"The lesson we learned from it, was how hard it is" to unwind sanctions, said Assistant Treasury Secretary Danny Glaser. "As it relates to Iran and the posture we find ourselves in, I think the point is ... it is difficult and complicated and you have to be very careful how you do it."

OFAC's POWER

OFAC got an unusual compliment in October, from a politically divided U.S. Congress that rarely agrees on anything.

Amid a government shutdown over a budget dispute, Republican and Democratic lawmakers joined in urging Obama to exempt OFAC's employees from furloughs, citing their central role in implementing and enforcing Iran sanctions.

Created in 1950 during the Korean War, OFAC is part of an activist national security division at Treasury that was revived after the September 11, 2001, attacks to develop new financial weapons against al Qaeda and other terror groups.

OFAC's budget - $30.9 million in fiscal 2013 - and staff have grown little in recent years. Outside lawyers complain it is stretched thin, overseeing 37 sanctions programs and dealing with sudden crises such as the one in Ukraine.

Despite OFAC's modest size, one visit from its officials can leave bankers and traders scrambling to fulfil its dictums, given its power to blacklist entities and levy fines.

It can put individuals on the list of "Specially Designated Nationals" - blocked from the U.S. financial system - without a court ruling or publication of often-classified evidence. Its standard is a determination that there is "a reasonable basis" to believe activity is occurring that merit sanctions, not the stricter legal standard of "beyond a reasonable doubt."

"There's no appetite for running afoul of OFAC," said Samuel Cutler, policy adviser at Ferrari and Associates, which handles sanctions-related litigation. Even with some Iran sanctions now eased, U.S. and foreign businesses won't risk Treasury's wrath by rushing to do business with Iran, Cutler predicted.

A few targets of Treasury's sanctions have struck back in court, claiming unfair treatment.

In 2010, for example, a federal court ruled that Treasury had violated the due-process rights of a charity known as KindHearts by freezing its assets without a warrant. Treasury argued that the freeze was necessary to prevent KindHearts from hiding assets that U.S. officials suspected were going to Islamist militants. The case ended in a settlement in which KindHearts folded but was allowed to keep its assets.

GLOBAL FINANCIAL WARFARE?

Before new sanctions are announced publicly, OFAC coordinates with the Justice Department, which might have to defend the action in court.

It also confers with diplomats, spies and law enforcement officials to determine whether the proposed sanctions could complicate their work.

U.S. success in using financial sanctions against targets such as Iran has prompted other countries to expand their own sanctions capabilities.

A former OFAC official who asked not to be identified recalled a 2011 meeting with Chinese officials, who bombarded him with technical questions about OFAC and its powers. China was developing its own laws to authorize unilateral sanctions, he later confirmed.

"I am not sure we're ready for a world where the Russian Federation and People's Republic of China start having their own lists where they're sanctioning people," the former official said.

(Additional reporting by Babak Dehghanpisheh in Beirut and Mari Saito in Tokyo; Editing by Alistair Bell and David Lindsey)